Assets to hold if inflation drops but the economy jumps

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In the final part of the series, Trustnet examines which assets to hold in a “golden loop” scenario where inflation is falling but economic growth is rising.

Liz Truss’ goal in becoming Prime Minister was to stimulate economic growth. Although it now seems more likely that we will enter a recession in the short term as the Bank of England raises interest rates, who knows what the environment will look like in the medium to long term?

In a series of Trustnets, we look at which assets to hold and which to avoid in each of four outcomes based on current government and Bank of England targets: The Bank wins and inflation falls, but at the cost of the growth ; the government wins, with higher growth, but inflation is still out of control; a “doomsday” scenario of higher inflation and weak growth; and finally the “golden loop” option, with falling inflation and rising growth.

Alena Kosava (Photo), head of investment research at AJ Bell, said the latter environment is likely the least likely on a balance of probabilities, as central banks are “myopically focused on controlling inflation, having lagged behind inflation.” curve and losing their credibility”. However, she said it’s possible that any decline in global readings will ease some of the pressure on central banks and slow the pace of the rate hike cycle.

“With that, the parts of the market that were hit the hardest, including growth stocks and long-lived assets, will likely recover some of the underperformance,” Kosava added.

Tom Kynge, assistant fund manager and portfolio analyst at Sarasin & Partners, said this type of environment would be reminiscent of the “post-2008 investment playbook” supporting fast-growing businesses such as technology companies.

“More speculative investing would come back into vogue as borrowing costs drop and funding appetite increases – think small caps and cryptocurrencies,” he said.

Asset market valuations would rise. Assets that provide shelter in turbulent markets may underperform. Companies in the healthcare sector prove less attractive when technology companies can finance their growth prospects at low rates.

James Sullivan, head of partnerships at Tyndall Investment Management, agreed.

“This time it would be high-beta momentum stocks that tend to outperform, coupled with a bias towards cycle-sensitive mid-caps that benefit from lower input prices,” he added.

“Thus, we consider consumer discretionary, technology and communication services as sector styles, while avoiding inflation beneficiaries such as financials and energy.”

In an article published yesterday on Trustnet, Vince Childers (Photo)head of real assets multi-strategy at Cohen & Steers, said commodities would “lead the way” in a period of rising inflation and economic growth.

But in a scenario in which the economy grows while inflation falls, he said while natural resources stocks would offer above-average returns, commodity futures would underperform.

Another area likely to underperform is cash.

“Lower inflation leads to lower interest rates, which means saving cash pays little dividends,” said Baylee Wakefield, multi-asset fund manager at Aviva. “As economic growth increases, the opportunity costs of holding cash increase.”

Paras Anand, chief investment officer at Artemis, said this relates to a risk that investors might overlook in the current environment: opportunity risk. With all the attention on the downside, many investors may take an overly defensive stance just when potential returns are at their highest.

“For there to be more of a downside in the equity or high yield markets, you would have to see some type of economic downturn that would fall under the banner of ‘crisis’, where you have a high level of defaults or you have a larger negative impact on corporate earnings growth, primarily on the demand side of the equation,” he explained.

“Therefore, given that a significant downturn/recession is already priced into many public market stocks, one could argue that many major asset classes offer attractive value at this time.”

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